Doctor Copper’s October Heart Attack: Dwindling global copper supplies spike highest-ever spreads on LME
London Metal Exchange enacted emergency trading limits to halt run on copper exchange inventories
This story covers the October 2021 copper market mini-crisis. My previous piece giving a general overview of the global copper market can be found here: Electrifying the global copper market.
Doctor Copper
There are instances, from time to time, where markets seize up—freeze—or panic. The normal day-to-day operations by market participants are often motion-going. A natural tendency to sleepwalk through trading positions. But there are days when within minutes, a groggy market corrects to a sobering reality. This was the case for copper traders the weeks of October 11 and 18, 2021.
Economic forecasters often refer to the copper market as “Doctor Copper.” The idea is given the broad use of the base metal across various consumer and capital goods, it possesses inherent prescriptive properties on where the economy is headed. Price is what financial physicians use as the heartbeat in their macroeconomic prognoses. Recent events may indicate further systemic issues within the broader commodity space.
The October Crisis
October 11, 2021 began a series of unprecedented events for the global copper market. The largest copper exchange in the world, the London Metal Exchange, was staring into the abyss of a technical default. Over the next several days, the LME’s physical stockpiles of copper would plunge over 90% from the month before. Late in the week, copper stores stood at just 14,150 tonnes available in a market where over 20 million tonnes are consumed annually. These were the lowest levels seen since 1974 when the market was much, much smaller.1
“Right now the LME is running a physical contract that effectively is not really backed by physical metal.”
- Michael Widmer, Senior Director of Metals Research - Bank of America
Spreads skyrocketed as a result. The cash-to-three month copper delta spiked to $1,103.50/tonne on October 18.2 What this means is the cash, or spot, market for copper today—the physical market—was at a +$1,103.50 premium to copper delivered 3 months out. Typically, there is a positive cost of carry in futures markets. The further you go out for a contract month there is a built-in premium reflecting the cost of storage and insurance of whatever commodity or good your contract is for.
Copper was facing extreme backwardation—where demand for immediate delivery of copper pushed spot premiums substantially above 3-month. Backwardation often is a reflection of fear of physical shortage within the marketplace. Conditions became so acute during mid-October the inverted spread was over 10% of the underlying commodity’s price. To say this is atypical would be an understatement. The market was genuinely panicked to the point it would pay you over 10% rate of return to defer your copper delivery by 3 months. And some did.
Re-delivery became an attractive arbitrage opportunity for patient buyers. Flows began to reverse as prices enticed restocking physical copper into LME warehouses. It worked. Cash-to-three month spreads corrected from $1,103.50/tonne on October 18 to $280/tonne by October 20.3 Although the market remained in significant backwardation, the premium cratered 75% within 48 hours. Today, that spread is down roughly 98% from peak to around $20/tonne, still in backwardation at the LME.
The London Metal Exchange
Founded in 1877, the London Metal Exchange is, “The world centre for the trading of industrial metals – the majority of all non-ferrous metal futures business is transacted on [the LME].”4 The LME serves as a market of last resort where firms and individuals can turn to no matter the market conditions. October 2021 put that to the test.
Trafigura is the world’s largest copper trader accounting for 4.4 million tons a year. This represents roughly 18% of total annual copper production globally. They were also found to be the primary force behind the draining of copper supply at the London Metal Exchange.5 The ensuing market strain pushed the LME to adopt temporary measures to alleviate the extreme backwardation. New rules are being looked at to alter the structure and function of the exchange on a permanent basis.
“Should it be the case that any LME trader can turn up to an LME warehouse and book out as much metal as they want, even if that could have a potentially disruptive effect on the market?”6
- Matthew Chamberlain, CEO London Metal Exchange (LME)
Conclusion
It’s been several weeks since the October mini-crisis in copper. Conditions have eased, but remain tight. Sentiment in the overall copper market is for sustained bullish outlook. Backwardation is still persistent and inventories have recovered from their October nadir. Currently, the LME has just above 84,000 tonnes of product, up from the lows in the mid-teens seen in early autumn.
I do think the copper market is yet another example highlighting strained global supply chains. Metals are inherently long-lead time commodities where mines take 14 years to come online. Economic disruptions only make supplies even more uncertain for a product necessary in every day industry.
Further, Doctor Copper may point to other commodities evidencing similar shortages. The doctor could serve as a canary in the coal mine for the broader metals markets where complacency is the norm. As we saw in October, confidence can be rather fickle.
Burton, Mark. October 15, 2021. Global Copper Inventories are getting critically low. Bloomberg. https://www.bloomberg.com/news/articles/2021-10-15/copper-spread-spikes-to-record-in-latest-sign-of-tight-supply
Home, Andy. Column: London Metal Exchange has to restrain disorderly copper. Reuters. https://www.reuters.com/business/energy/london-metal-exchange-has-restrain-disorderly-copper-andy-home-2021-10-21/
Mason, Alice. October 21, 2021. LME copper backwardation begins to narrow; participants mull implications of new measures. MetalBulletin. https://www.metalbulletin.com/Article/4012773/LME-copper-backwardation-begins-to-narrow-participants-mull-implications-of-new-measures.html
London Metal Exchange. Retreived January 9, 2022. https://www.lme.com/en/Company/About
Farchy, Jack, et al. October 19, 2021. Trafigura played key role in draining LME copper inventories. Bloomberg. https://www.bloomberg.com/news/articles/2021-10-19/trafigura-played-key-role-in-draining-lme-copper-inventories
The Star. November 12, 2021. LME mulls rules to keep metal from running out after chaos. https://www.thestar.com.my/business/business-news/2021/11/12/lme-mulls-rules-to-keep-metal-from-running-out-after-chaos.